As a practical matter, many CPAs are unaware that spousal support, also known as alimony, is not automatically deductible to the payer and taxable to the recipient unless it meets particular requirements. Similarly, clients and other parties often assume that spousal support is always income to the recipient and a deduction for the payer.
The IRS views alimony as tax rate arbitrage because, usually, the person paying the support is in a higher tax bracket than the recipient. The author, in her role as a Certified Divorce Financial Analyst (CDFA), shows the after-tax cost to the payer and the after-tax income to the recipient from spousal support payments. A critical point in this analysis is determining whether spousal support qualifies to be treated as tax-deductible alimony.
The portions of the Code that prescribe the treatment of spousal support are Secs. 61, 71, and 215. The best way to paraphrase Sec. 61 is that everything is income unless the Code contains a specific exception. Alimony and separate maintenance payments are specifically included in gross income under Sec. 61(a)(8). Alimony is defined in Sec. 71. Sec. 215 discusses the payer’s deduction and refers to the Sec. 71 requirements. A simpler and easier guide to access is IRS Publication 17, Your Federal Income Tax: For Individuals. This is a key resource for making practitioners aware of how the IRS looks at thetransaction.
The three biggest questions faced in this area are the following:
- How can alimony not be taxable to the recipient or deductible by the payer?
- Is temporary support deductible?
- Are lump-sum alimony payments or buyouts deductible?
Alimony and Temporary Support
The simplest response to the first question is that if a payment does not meet the requirements of Sec. 71, then it is not considered alimony for income or deduction purposes. However, even if the payment does not qualify as alimony, assuming the payment is between spouses, or to a former spouse “incident to the divorce,” it would be exempt from income or gift tax under Sec. 1041(a)(2). Payments made within one year of divorce or related to the divorce or separation agreement and made not more than six years after the divorce (as described in Temp. Regs. Sec. 1.1041-1T, Q&A-7) are considered incident to the divorce. In such instances, the recipient would not be required to report the payment as income, and it would not be deductible.
Often, what is buried in this question is why someone would want the payment to be taxable or not. As indicated in the introduction to this discussion, alimony can amount to tax rate arbitrage if it is taxable.
Read the full article on the AICPA Tax Adviser site here.
Meet the Author
Senior Tax Manager
Elizabeth Hutchison, CPA, CDFA
In 2010, Elizabeth joined the firm’s Portland team with three years of experience in public accounting at a Big Four and local accounting firm. Going beyond compliance, Elizabeth’s role at the firm is both problem solver and strategic tax planner. Her expertise allows her to help her clients navigate the complex nature of tax laws.…
- High-net worth individuals and business owners
- Strategic tax planning and compliance
- Divorce support
- Certified Public Accountant
- Certified Divorce Financial Analyst (CDFA)